Independent Bank Corp Q3 FY2020 Earnings Call

Welcome to the Independent Bank Corp. Third Quarter Earnings Call. Before proceeding, let me mention that this call may contain forward-looking statements with respect to the financial conditions, results of operation, and business of Independent Bank Corp. Actual results may be different. Factors that may cause actual results to differ include those identified in our annual report from Form 10-K and our earnings press release. Independent Bank Corp. cautions you against unduly relying upon any forward-looking statements and disclaims any intent to update publicly any forward-looking statements, whether in response to new information, future events, or otherwise. Please note that during this call, we will also discuss certain non-GAAP financial measures, as we review Independent Bank Corp.'s performances. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings press release, which contains reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and additional information regarding our non-GAAP measures. Also, please note that this event is being recorded. I'd now like to turn the conference over to Mr. Chris Oddleifson, President and CEO. Please go ahead.

Thank you, Nick, and good morning, and thank you, everybody, for joining us today. With me as usual is Mark Ruggiero, our Chief Financial Officer. And we'll be again joined by Rob Cozzone, our Chief Operating Officer; and Gerry Nadeau, President of Rockland Trust and our Chief Commercial Banking Officer, who will be available to answer any of your questions. We wish again to extend our hopes for continued well-being to all of you and your families during this prolonged health crisis. As we continue to persevere and adapt during the COVID pandemic, we are encouraged by our continuing ability to produce strong business results, as demonstrated by our solid third quarter performance. Third quarter net income came in at $34.9 million or $1.06 per share, well above the prior quarter. This is attributable to the strength and resiliency of our business model and by Rockland Trust colleagues. Mark will be covering the quarter in greater detail, including a comprehensive review of our credit picture and trends, which have played out as expected, especially in the highest risk industries we've previously identified. I'll start with a note on the Massachusetts economy. The unemployment rate is 9.6% in Massachusetts as of September, down from a high of 17.7% in July and up 6.8% since January of 2020. It is the seventh highest in the U.S. Although we see high levels of unemployment, we know the first round of economic stimulus has buoyed economic activity. In fact, consumer spending in this state is up 5.9% since January of 2020. Much like the rest of the nation, we are seeing a shift in consumer spending activity, and a shift in activity will have meaningful impacts on our local businesses, some positive and some negative. The economic outlook has been influenced by the CECL requirement, which has been fully incorporated into our loan loss provision. The third quarter benefited from a lower loan loss provision, and there were many positive trends in our business fundamentals as well, including strong fee income, solid commercial loan growth, continued core deposit growth, expense control, ample capital liquidity levels, a return on assets back above 1%, and sustained tangible book value per share growth. None of these changes the fact that much uncertainty persists during this crisis with no segment in the economy or society immune from its impact. For us, relationships remain our top priority as we strive to reduce burdens and anxieties while the crisis continues to unfold. We feel this true character of Rockland Trust has been even more evident to our customers and colleagues during this period, leading to our solid performance. Our core businesses are really meeting the challenge, and the diversity of our business lines and service offerings are buoying our resiliency. Under Gerry's leadership, our commercial bankers remain in deal flow and are still gaining new business under good terms despite the many challenges. In fact, our loan closings this year are running neck and neck with last year's levels. Our pipelines remain in good shape as well. Our deposit generation continues at a high level, recognizing the value of core deposit funding. We are leveraging all our learnings from the COVID experience to shape our brand strategy. As other banks announce plans to reduce their branch footprint, we see this as an opportunity to capitalize on relationships, looking to a bank with a branch-anchored trusted adviser. This strategy has fueled record levels of new account openings during this period. Our branches also continue to be an important source of referrals to other parts of the bank. Our mortgage operation, one of Rob's businesses, continues to generate record volumes in this low-rate environment. Our expanded capacity resulting from the Blue Hills Bank acquisition allows us to accommodate the surge in demand. Our investment management group remains one of our prized businesses, with growing fee revenues and assets under management now reaching $4.5 billion. Our team has more than 80 professionals across 10 investment offices across our footprint, and the Rockland Trust brand remains strong. We continue to actively promote it via a rich blend of advertising and marketing campaigns. Our reputation for stellar service, product depth, and reliability reinforce its strengths. It has led us to earn new customer relationships and strengthen existing ones. Looking ahead, we will continue to look for ways to grow while adapting to our experiences and observations over the course of the pandemic. One area we're very excited about is our recent entry into the Worcester market. We opened our first Worcester full-service branch in February, and we're about to open our second full-service branch, and we couldn't be more enthused by our progress to date and the reception we have received. Commercial loan origination levels have been strong as our hiring of experienced commercial staff in that market is really paying dividends. We also continue to invest in our mobile and digital technology to keep pace with the growing customer preferences. No question, one of the takeaways in the past six months is the growing customer reliance, expectation, and comfort level for these channels, especially notable is the uptake in the use of these channels among more senior individuals. Witnessing the ease with which our customers could pivot to these channels is strong validation of the investments we've made in this area. We also continue to augment our risk management efforts to address the added challenges posed by the current environment. Additionally, we plan to take a hard look at ways to further improve our operating efficiency. As part of these efforts, we will continue to look for ways to improve our branch configuration while keeping a robust footprint, as discussed earlier. Throughout all this, we continue to balance short-term considerations against longer-term sustainability. In doing so, we expect to continue to produce solid results while enhancing our long-term profitability and franchise value. As always, I want to end my comments with heartfelt thanks to all my hard-working colleagues, who are the true secret sauce to our success, as they have so ably demonstrated over the last six months. And with that, I'll turn it over to Mark.

Thank you, Chris. I will now cover the third quarter results in more detail. GAAP net income of $34.9 million and diluted EPS of $1.06 in the third quarter of 2020 reflect increases of 40% and 39.5%, respectively, from the prior quarter's results, as reduced provisions for loan losses, focused expense management, and solid fee income drove strong core results despite absorbing the negative impact on consumer-related fees caused by the commencement of the Durbin Amendment. Also included in the third quarter results was a one-time loss associated with the termination of a hedge derivative, which, when excluded, results in third quarter operating net income of $35.4 million or $1.07 diluted EPS. These results drove a notable increase in return on assets to 1.07% for the third quarter. Pretax pre-provision return on average assets of 1.64% or 1.66% on an operating basis remained consistent with the prior quarter despite continued pressure on asset yields. It is also important to note that both quarter metrics were negatively impacted by the outsized level of excess liquidity on the balance sheet. Focusing first on credit, we will highlight certain elements of the loan portfolio that have been of heightened interest to the investment community. I will first provide an update on loan deferral activity. As referenced in Appendix F of our earnings release, total loans subject to future deferral dropped to $584 million or 6.2% of total loans as of September 30, 2020. Included in the reduction were approximately $275 million of loans that reached their deferral maturity date in September. As we talked about last quarter, we continue our disciplined approach of ensuring updated financial information and assessment of cash flow viability in considering whether to grant a request for any additional deferral. As such, although we expect a portion of these recently mature deferral balances to enter into another round of deferral, particularly in the hotel industry, we anticipate the level of total deferrals to continue to decrease through the fourth quarter. On a similarly positive note, although early in the process of working with those recently ended deferrals, we are starting to see those looking for further relief to be agreeable to a transition from a full-payment deferral to a principal-only deferral and any further extension. In terms of other credit developments during the quarter, nonperforming loans increased $49.2 million during the quarter, driven primarily by the migration to nonaccrual treatment for three large commercial customers, including a $3.8 million charge-off associated with one of those relationships. Not surprisingly, these three relationships were all included in the previously identified high COVID impacted industries. We are hopeful that management's proactive approach to identifying problem loans and possible workout solutions will lead to near-term resolutions. Rounding out the credit discussion, and as mentioned in last quarter's call, management continues to leverage the information contained in the various appendices regarding absolute levels and migration of deferral activity as well as overall exposure to industries heavily impacted by the ongoing pandemic to drive the allowance and related provisioning process. In general, the overall credit picture and our future outlook for loss estimates have not changed materially from what was assumed last quarter. As such, the third quarter provision for loan losses of $7.5 million reflects a significant decrease from the $25 million and $20 million provision numbers booked in Q1 and Q2, respectively. Given that the emergence of these loss exposures was already contemplated in the life of loan loss estimates conducted in the previous quarter, the September 30 allowance as a percentage of loans only increased minimally to 1.23%. As a quick update on our PPP program, the company closed on another $18.7 million of PPP loans in the third quarter, bringing the total outstanding balances associated with the program to $812 million as of September 30, 2020. In addition, while we have started to receive applications for the loan forgiveness process, similar to other banks, no SBA issued forgiveness has been granted to date. As such, there's been no meaningful acceleration of PPP fees recognized during the quarter. Of the $27.1 million in fees expected to be earned through the PPP program, $5.4 million has been amortized into income on a year-to-date basis with $3.2 million recognized in the third quarter. Please refer to Appendix C for more detail on the loan balance and income recognition associated with the PPP loans on a quarterly basis. Lastly, although we anticipate some level of fee acceleration in the fourth quarter of 2020, the amount and timing continue to be affected by the ongoing rollout of the SBA forgiveness process. It is also important to note that as PPP loans are forgiven, the asset conversion from loan to cash will further strain the near-term liquidity position and effective deployment of cash in this environment. As the PPP program and other government support continues to unfold, the level of cash preservation in our customer base, combined with strong Q3 deposit growth, has led to significant excess liquidity on our balance sheet, which, in turn, continues to cause a drag on our reported net interest margin. The third quarter reported margin of 3.13% reflected a decrease of 12 basis points from the second quarter levels. However, as detailed out in Appendix C, when excluding the impact of PPP loans, excess cash balances, and other one-time items, the core margin decreased by 7 basis points quarter-over-quarter. A notable component of this decrease reflects the reversal of $1.6 million of interest associated with the loans that moved to nonaccrual status in the quarter, a number that is higher than a typical three-month past-due interest impact due to the unique dynamic of the deferral programs. The rest of the margin compression can be attributed primarily to continued pressure on asset yields due to the repricing of assets in this low-rate environment, offset by reductions in deposit costs. Although we expect asset yields will continue to be pressured moving forward, we believe there are still opportunities to decrease deposit costs to partially mitigate the net impact in the near term. Lastly, we decided to exit the $100 million hedge that we entered into earlier in the year in connection with our increased FHLB borrowings positions. With the steady buildup of liquidity experienced over the last six months, we were comfortable exiting the hedge in the third quarter and paid off the $100 million in borrowings upon maturity in early October. The cost to exit the hedge of $684,000 is included in noninterest expenses in the third quarter results, and the savings on interest expense on the reduced borrowings will be reflected in the margin prospectively. I'll now provide a bit more color over some other third quarter results. When excluding PPP activity, total loans increased $26.8 million or 1.2% on an annualized basis, with 8% annualized growth in commercial loans being offset by continued runoff in the consumer portfolios. The large drop in C&I utilization that we discussed last quarter has leveled off here in the third quarter. Despite macro-level headwinds, challenging loan growth in the current environment, we were able to close on a number of deals across all commercial categories, driving solid commercial loan growth noted in the quarter. In fact, following up on Chris's point, our year-to-date commercial loan closings through the third quarter are $981 million on a total commitment basis. This represents 98% of total new commitments that were booked through the third quarter of 2019. We continue to remain diligent and cautious over deal flow with prudent underwriting that reflects not only the uncertainty in business financial stability but also that of collateral valuation. Working within that credit framework, we are cautiously optimistic that with an approved pipeline at September 30 of $216 million, it should bode well for fourth quarter closing activity. On the consumer side, we have seen record volumes from mortgage activity, with the majority of the activity being sold in the secondary market. Combined with continued refinance and payoff activity, net portfolio balances continue to attrite, while mortgage banking income increased significantly. Similarly, on the home equity side, we are seeing better-than-expected demand for new closing activity as well. However, attrition continues to challenge overall net growth. As we look out into the fourth quarter, the mortgage pipeline is consistent with what we entered into the third quarter, and the home equity pipeline has increased over 50% from prior quarter levels. On the deposit side, and as referenced earlier, a number of factors continue to drive strong core deposit balances. In addition to government stimulus money and increases from existing business and consumer accounts, we continue to see increased opportunity for new deposit relationships, as evidenced by record new core checking accounts opened over the last three months, despite the muted economic environment. As guided last quarter, with higher cost time deposits continuing to run off and further reductions made to deposit costs across the board, the cost of deposits dropped to 20 basis points in the third quarter, with the ability to decline further in the near future we believe. To echo what Chris said earlier, our branch strategy in comparison to various other banks' retrenchment practices has been instrumental to our robust new business generation. While digital product development and operating efficiency are top priorities as we look into the future, we continue to see value in the branch network as a key tool in generating profitable core customer relationships. Finally, regarding funding, the low level of total borrowings remained unchanged quarter-over-quarter. As previously discussed, the goal is to further reduce borrowings where opportunities arise, including the already mentioned $100 million pay down in Q4. Capital levels remain in fine shape with an equity-to-assets ratio of nearly 13% and tangible common over 9%. This provides ample resources to support dividend payments, future asset growth, or further stock buyback considerations. Turning to noninterest items, we will highlight a few key items to note for the third quarter. Regarding noninterest income, deposit service charges and ATM fees experienced a rebound in the third quarter from the significantly depressed levels experienced in Q2, which were heavily impacted by the COVID-19 pandemic. The reduction in interchange income from the Durbin Amendment was as expected, with overall spending activity increasing slightly from Q2 levels. Regarding wealth management, although new money generation continues to be challenged by the current environment, market performance drove a 3.3% increase in assets under administration, resulting in increased fee income quarter-over-quarter, despite seasonal tax preparation fees included in the prior quarter's results. As noted earlier, the mortgage banking income set a new record in the third quarter, continuing to serve as a natural hedge against the impact of the current low rate environment. With the aforementioned healthy September 30 pipeline, origination activity is expected to remain strong through the fourth quarter. On a similar note, loan-level derivative income remained elevated at $2.5 million for the third quarter. Regarding noninterest expense, despite notable increases in the FDIC assessment as expected and the loss on the termination of the hedge derivative, total noninterest expenses remained relatively flat with the prior quarter, as disciplined expense management remains a hyper focus through this challenging environment. As Chris stated earlier, operating efficiency remains a strategic priority of the organization, and we are looking intently at legacy costs to challenge where there may be opportunities for improvement. Any decisions, of course, will be looked out through the lens of improving long-term profitability. Lastly, the tax rate of 24.3% for the third quarter was in line with expectations. That concludes my comments, and we'll now open it up to questions.

The first question is from Mark Fitzgibbon of Piper Sandler.

I'm wondering if you could provide some additional details about those three large loans, such as the size of each loan, whether they are secured by real estate, and what the loan-to-value ratios might be. That would be great.

Sure. I'll provide some high-level information, and Gerry is here as well to add to the discussion as needed. We mentioned three relationships that are moving into nonaccrual status. One is in the hotel industry, one in the foodservice industry, and one in the arts and entertainment industry. The balances for two of these are in the $18 million to $20 million range, while the other is about $12 million, totaling over $50 million, which accounts for most of what went into non-performing assets in the third quarter. The hotel loan is secured by real estate, the restaurant loan has a combination of real estate collateral and other business assets, and the entertainment loan is mainly secured by real estate. Importantly, we are actively working on resolutions for two of these relationships in the near term. We have been proactive in assessing high-risk industries and identifying relationships that could jeopardize long-term cash flow. These three have been recognized as the top risks at this stage. We decided it was wise to move them into discretionary nonaccrual status rather than allowing long-term deferrals. Our goal is to resolve these issues and minimize potential losses as quickly as possible. I hope this information helps, Mark.

It does. And I guess, as you look at the $583 million you have on deferral now, and I know it's a tough question to answer, but how much of that, theoretically, do you think could end up on nonaccrual, absent additional government stimulus or intervention?

Yes. Like you say, it's certainly difficult to pinpoint. I think the positive aspect that we are experiencing is for those that are continuing to stay on any sort of deferral program. And this is somewhat anecdotal with really some of the more recent loans that came to the end of their maturity period on the deferral that we're continuing to negotiate with. But the positive development there is that we've actually been able to get a good portion of those from a full-payment deferral to a principal-only deferral. So our position is that if we are continuing to get interest collection payments through the deferral process, we feel that's a fact pattern that allows and represents that these are accruing loans. Any migration in the future to nonaccrual would likely follow a fact pattern where the borrower may be looking to get deferral but would continue on a full-payment deferral. We would need to really look at that situation on a one-off basis, see if we are comfortable with whether that does allow enough of a time period for the customer to cure whatever cash flow issues they may have and feel and get us to a position that we feel comfortable that when they come out of the deferral period that we actually have an accruing loan and we'd be able to get that deferred interest in the long run. So we're looking at these very much on an individual basis. I think the strong point of our business model is that we're very much a relationship business bank. We know our customers well. Our lenders are talking to them very often throughout this pandemic. We really have a good pulse on what the cash flow and future viability looks like. We'll continue to be proactive in identifying those that we think makes sense to put on nonaccrual. As we sit here today, we believe we've really identified the top exposures at this point.

Okay. And then it looks like you're carrying sort of $800 million or $900 million of excess liquidity on the balance sheet. Can you give us some sense for how long you think it might take to kind of bring that down to a more manageable level?

Yes. This is certainly one of the biggest challenges we face in the current environment, especially regarding core profitability. As I mentioned earlier, a unique factor is that as the PPP loans are forgiven over time, they will convert into additional cash, which creates a headwind for cash balances. However, we have several opportunities to address the excess liquidity. We discussed the borrowings prepay we already completed, and we have a number of higher-cost CDs rolling off soon. There may also be other borrowing prepay opportunities that we will pursue aggressively when appropriate. Recently, we've seen a slight increase in long-term rates, and given our asset sensitivity position, we feel comfortable investing more in the securities portfolio. We have been cautious about deploying excess liquidity aggressively in this area, as it hasn’t been an optimal investment environment. However, we now see an opportunity to invest more in the securities book for better returns than what we earn at the Fed. Our loan pipelines remain strong, and we have the potential for loan growth despite some challenges with payoffs and attrition. On the consumer side, mortgage lending is another area where we are becoming more willing to retain high-quality credits in our portfolio instead of selling them in the secondary market. While we’re not planning a significant change in how much we retain, we believe we can make incremental increases in that direction. Overall, we aim to balance the need for improving short-term profitability without compromising our long-term position, which we believe would not be beneficial for the company.

So last question. Excluding PPP impact, the core margin is going to continue to come down, but maybe at a slower rate than we saw this quarter. Is that fair?

I think that's very fair, yes. I think when you strip out the excess liquidity, if you consider that staying equal, I think we've shown in the third quarter, we've been able to do a nice job of making cuts on the deposit side to really equal and mitigate a lot of what we're seeing on the asset repricing impact. So we think that can continue to be the case, at least for the next couple of quarters. We have some ability to keep moving on the deposit side. So I think we'll be able to temper the margin compression.

Just one final question, if I might. There was a large demutualization in your market with a new big company with a lot of capital. I'm just curious, are you seeing any impact on pricing on either side of the balance sheet from that?

I'll defer maybe to Gerry, if that's okay, to just give a little bit of color on what the market conditions are.

Hi, Mark. Regarding Eastern Bank Corp, we have sufficient liquidity in the marketplace to make the loans they want. They have historically been disciplined lenders in terms of credit and pricing, and I don't expect that to change just because they raised this capital. Market pricing has actually improved, with wider spreads and better flows for larger loans. However, smaller loans continue to pose challenges for some nonpublic thrifts and mutuals. Eastern has been around for a long time and has maintained a disciplined approach, so I don't anticipate a quick change in their behavior.

Next question comes from Christopher Keith, D.A. Davidson.

So just, I guess, digging a little bit more into the margin. I was wondering if you could give me a sense for what new commercial real estate loans are coming on at? And maybe a sense for what set to reprice over the next few quarters?

Sure. Without going into specifics about our pricing decisions, I can share that in the third quarter, we observed an increase in spreads in some of our swap activities within the swap portfolio. We are still finding fixed-rate deals with floors that align well with our pricing strategy. In terms of recent activity, the commitments we finalized in the third quarter have been booked at an average margin that is about 40 basis points higher than what we had in the second quarter. This is a positive indicator for maintaining and protecting the overall level of rates in this lower rate environment. This new development in the third quarter should contribute positively to the asset repricing aspect. Additionally, we've made reductions on the deposit side and believe we can continue to do so to alleviate most of the asset yield compression.

That's great to hear. I wanted to ask about noninterest income, specifically regarding the ongoing strength in mortgage banking. You've managed to increase it even beyond the highs from the second quarter. I'm curious if this increase is based on the third quarter or if it's a reflection of the sustained strength compared to lower historical figures, with the possibility of a slight decline in the upcoming quarters.

Yes. I mentioned that our pipeline heading into the fourth quarter is very similar to where we were at the start of the third quarter. This gives us a good perspective on the overall situation. All else being equal, we would expect to see at least comparable closing activity. However, given our asset sensitivity and liquidity position, we believe there’s an opportunity to shift more production onto our portfolio. If we find those opportunities in the fourth quarter, it would impact the immediate profit and loss results of mortgage banking income but would benefit interest income and our balance sheet. This is the main consideration as we look at new originations through the fourth quarter, which might shift some mortgage banking revenue into portfolio interest income. Overall, it should remain fairly comparable quarter-over-quarter.

Next question comes from Laurie Hunsicker, Compass Point.

I just hoping we can go back to your commercial detail, and I love the detail you give as always. But leveraged loans, can you update us on where that is? And what's in deferral there? And if you have it, the amount that appears in your highlighted commercial categories, that $1.3 billion, how much of the leverage loan book is in there? And if you don't have this, I can follow up with you off-line.

Yes. I'm just looking through real quick here, Laurie, I don't believe I have the leveraged loan isolated at this point.

Okay. I'll follow up with you offline.

I can certainly get back to you on that.

Okay. Just looking at the expenses, I'm wondering how we should think about that? And maybe you can refresh us just in terms of how you're thinking about a de novo strategy now? I mean you've got a second one just about to open. How are you thinking about that for next year? How many branches are you guys potentially considering?

Sure. I'll let Rob maybe take the lead on that as he is sort of driving the branch strategy, and in particular, Worcester in that region is really the priority heading forward in terms of any sort of branch increase initiative. But I'll let Rob give a little bit more color there.

Thanks, Mark. Good morning, Laurie. As Mark or as Chris had mentioned, Laurie, we are planning another branch opening in the City of Worcester in the next quarter here. Our third Worcester area location is expected to open in the first quarter, probably early in the first quarter. We have not identified formally any additional locations beyond those next two, but we would like to open at least one more location, continuing our expansion along the Route 9 corridor from our Eastern franchise to our new footprint in Central Massachusetts in 2021. I would suspect that would not certainly mean any more than two additional locations. So we have one, we're adding another in the fourth quarter, a third in the first quarter, and then maybe one or two more after that. In addition, we continue to look at opportunities for selective consolidations. As Chris mentioned in his opening comments, we find significant value from our branch franchise for all of our businesses, frankly. We do not plan any sort of significant consolidation. But as we have done over the last decade, we regularly look for opportunities to consolidate where it makes sense. I suspect that will continue to be the case in the coming quarters and years.

Okay. And I guess, along those lines, at one point, this probably rewinds now two years ago. I guess Chris had suggested potentially you all would like to at some point to be $20 billion or so in the Greater Boston MSA, which certainly means acquisition. Can you help us think about, I guess, size that you would consider? And then also maybe just comments about pursuing an acquisition now during the pandemic or how you think about waiting, how you see clarity on credit, just how you would approach that?

I think Chris could provide some insight into the overall situation, and then I can elaborate on our perspective regarding credit considerations and related matters.

Can you hear me now?

We can.

I apologize for the issue with my mute button. Laurie, I'll address your question in reverse order. Historically, we have made an acquisition every two to three years and we aim to continue that trend as it complements our growth strategy. We have been very disciplined in our market and do not pursue strategic deals lightly. While we remain open to discussions, it's essential to be cautious given the current uncertainty and our multiple ongoing initiatives. I would not want to pass on a potential acquisition that could benefit us and allow someone else to take it instead. The possibility is quite situational, and it really depends on a variety of factors. Regarding size, our previous acquisitions like Ben Franklin and Blue Hills represented about 35% of our current size, and we managed both without any issues. I'm open to pursuing something larger. If we were to consider a merger of equals, it's crucial for one party to take the lead as the acquirer, which is also an option for us. You're correct that the current uncertainty is a factor that necessitates further thought on our part. I hope this provides you with some insight, Laurie.

That's super helpful. Maybe if I could just ask one more question, too. Mark, I think you mentioned buybacks in your comments. I guess, Chris, how do you think more broadly about the timing of buybacks? I mean, presumably, you're really starting to think about it? Or you wouldn't have necessarily mentioned it in your comments, but how do you think about that?

The timing of our stock buyback relative to acquisition, was that your question, Laurie?

Yes. In other words, thinking about buybacks here, is that something potentially you're going to explore between now and the end of the year? Or waiting another quarter?

Now that Mark will give more insight, I don't believe the two are mutually exclusive, and I would like Mark to elaborate further.

Sure. Certainly, the reality of the stock price performance over the last quarter, we've certainly seen the valuation come in. As we look out into the near term, although we're very optimistic about our growth potentials, we've never been a historically large organic grower. In this environment, the prudent thing would be to continue to make loan and deposit growth in a very prudent manner. The combination of minimal expected organic growth and the absolute levels that we have now today in capital despite the large provisioning we've taken and we do our stress modeling, we are very comfortable with the capital levels that we have today. It's certainly an avenue that we would see in the near future that we need to be thinking about. This environment has a lot of uncertainty around it, and it would all be predicated on our ability to play out those stress scenarios and feel comfortable about where capital levels would be after. But it's certainly something that is front of mind, given all the dynamics we're talking about.

Our next question comes from Collyn Gilbert, KBW.

Maybe, Mark, can we start by discussing the NIM? I'd like to understand it a bit better. Could you remind us how much of your portfolio is tied to LIBOR and prime rates? Theoretically, that part of the portfolio should have already adjusted downwards. I'm trying to figure out when we might see this NIM reach its lowest point. So that's the first part of my question.

Yes. No, you're absolutely right. We've historically had about 40% of the book repriced to 1-month LIBOR or prime. To your point, that has occurred, and it was really the biggest impact of what we saw from the margin compression through the second quarter. Right now, the exposure we have is really just in terms of the absolute level of churn in the book and what will be coming off at higher yields and repricing into this environment. I think that if you look at the appendix we provide in the Appendix C, that equaled or equated to about 8 basis points of compression this quarter. I mentioned, we've actually been able to make some improvement on new originations in the third quarter. We're seeing spreads widening a little bit in some areas. I think that's a good baseline to be thinking about from a core perspective if the level of new volume and runoff is consistent with the third quarter. I think that 5 to 8 basis points range would play out in terms of yield compression. Our ability to move on the deposits and funding side to offset that would certainly drive your net margin impact.

Okay. You've partially answered my question already regarding the fixed-rate book and the expected near-term cash flows. I don’t need to go through the details since you’ve addressed it. However, I do have another question about hedging. Do you currently have any hedges in place that are benefiting your net interest income? And if so, when will those start to roll off?

We have $850 million in macro-level hedges against LIBOR-based loans, which have been highly beneficial since we started implementing them in 2019. Currently, these hedges are all in the money and have provided protection against rate declines over the past couple of quarters. We expect the first of these hedges to start rolling off later next year. We intentionally structured the maturity of these hedges to avoid significant write-offs in any single quarter. The $850 million in hedges will mature from 2021 through the end of 2024.

It's actually a little later than that, Mark, sorry, to interrupt. The first one rolls off in Q1 of 2022; the latter half of 2022. End of 2024 is when the majority rolls off.

Okay. Thanks, Rob.

That's helpful. Now, regarding credit, I appreciate the insight into the movements you observed this quarter and your outlook. If we were to quantify this, it seems that you are suggesting there's not a significant risk of migration in the upcoming quarter. Considering this information and your current observations, I would like to understand your expectations for the reserve and how it might normalize over the next one and a half to two years.

Yes. I think all things being equal, certainly, we need to account for various macroeconomic assumptions. If we assume that, that stays as we perceive it today, and the environment stays somewhat consistent, which we know there's pressure on small businesses in certain industries, but we think we've accounted for a lot of that with an outlook that expects strain on those industries well into 2021. Barring any changes to the macroeconomic forecast, I think we're in a position now where provisioning levels would really go back to being driven primarily off of net charge-off activity and loan growth. If we don't feel a need to build reserve based on macro factors, to the extent we can mitigate charge-offs, I think you'll see provisioning levels. You reflect that in, I think our current reserve levels, at least being sufficient to address the loss as we see it in the portfolio today.

Okay. That's helpful. My last question is for you, Chris. All three of you have mentioned it, but I'll start with you, Chris. Can you elaborate on your viewpoint regarding the significant value in your branches? This perspective seems to differ from what we're hearing from others and their approaches. What is it about your branches, your customer base, and your operations that leads you to still perceive meaningful value in that branch network and your ongoing desire to expand in that way?

Sure. I think I'm off mute. Can you hear me?

We can. Yes.

I will start and then Rob can add as well. Our core deposit franchise has been one of our greatest strengths over time. We believe this is entirely due to our community-based, relationship-focused branch network. In the short to medium term, and even looking 15 to 25 years out, we think there will still be a segment of the population that prefers to interact with branches in person or choose a bank with a physical presence just in case they need it. If we were to hypothetically reduce our branch network significantly or operate solely as a direct bank, we would no longer be competing within local communities but against national players, which could place us at a competitive disadvantage. Additionally, we receive a significant number of referrals from our branch relationships. For instance, our investment manager group has successfully built its business on referrals from branches and commercial bankers. There tends to be a mutual understanding among these businesses to refer clients to our investment management services for two main reasons: often, there is internal competition among different sales forces for the same clients, and commercial bankers are generally hesitant to pass along critical relationships to another unit, especially in matters concerning investment of personal funds due to trust issues. Before the pandemic, we generated between $300 million and $400 million annually from these referrals, which have been the primary driver of growth in our investment management business, yielding strong returns. We believe that relationships will remain crucial historically and in the near future. That said, one of the challenges with new technology is figuring out how to maintain relationships in a completely online environment. We are exploring some options in that area as well. Rob, what would you like to add?

You expressed that very well, Chris, and I have little to add. Along with our wealth management sector, most of our small business activity is generated through our branches in collaboration with our business banking officers. A significant portion of our home equity business also comes from our branches, and the vast majority of deposit accounts are still opened there. As Chris mentioned, we achieved a record number of new consumer checking accounts in the third quarter, with 90% opened at branches. Despite the challenges posed by COVID, we saw a threefold increase in online account openings, yet 90% of our demand deposit openings are still conducted in branches. Many banks discuss their retention rates after closing branches, claiming they retain 80% to 95% of deposits. We see similar outcomes; when we consolidate a location, we retain over 90% of those deposits, but no new customers come through those doors again. While we can maintain existing deposits, our ability to attract new business is significantly hampered by closing a location. We've covered a lot, but we believe that having our extensive geographic presence still holds substantial value. Ultimately, it's all about the personnel in those branches and how well they are integrated into the community, providing excellent service to customers when they visit. While that service may not be unique, we still have opportunities to set ourselves apart in service, as highlighted by various third-party reports.

Rob, to be specific, our third-party reports indicate that Forbes magazine ranks us as the top bank in Massachusetts for customer service, while J.D. Power places us second in New England. I can't disclose the identity of the bank ranked first in Massachusetts, but you can figure it out from that information. I also want to mention that I do not support the trend of other banks closing branches. I think that's a significant move, and I believe they might be feeling overwhelmed, so I would advise them to keep pursuing that strategy.

That could be a strategy in itself. That's really a great insight and good answers. I don't want to take too much time, but I have one follow-up. As we consider the need to be creative with our expense structure, especially given our current situation with rates, many in the industry highlight branches first as a way to rationalize costs. Within your organization, where do you see opportunities to be more efficient from a cost and operating perspective?

Rob, we do have opportunities for efficiency gains in our branch network. We are not suggesting that this is off limits.

Of course, not. That's exactly right, Chris and Collyn. There is still opportunity to become more efficient in our branches through technology both inside and outside of the branches. Our objective is to continue to shift transactions that do not add value to our digital channels, allowing us to enhance our conversations with customers when they are with us. As we achieve this, which we have already demonstrated we can do, it will enable us to reduce the total number of full-time equivalents per branch, thereby allowing us to gradually decrease the size of our branches and improve their efficiency. This is certainly part of our ongoing efforts to gain efficiencies throughout the retail network. In addition to specific consolidations, as I mentioned earlier, I want to clarify that we do see opportunities to consolidate locations, as we have done over many years. There certainly are opportunities, and we will continue to explore and act on them whenever it makes sense.

Next question is from Nathaniel Pulsifer of Pulsifer & Associates.

I have two questions. One on shares. What's the status of the buyback program?

The program we announced earlier in the year is complete. So that program is done. There's been no buyback activity since mid-second quarter. Any future activity would have to get reauthorized as a new buyback plan.

And the second is, what do you have in addition to required reserves with the Fed, what I would refer to as excess reserves?

I'm sorry. In terms of our outstanding cash balance right now?

Yes.

So we have well over $1 billion of cash at the Fed today.

That is over and above the required reserve.

Pretty much the required reserve has been pretty minimal at this point. On average, it ranges between $50 million and $100 million. So that $1 billion number in excess of that is on average where we have been.

This concludes our question-and-answer session. Now I'd like to turn the conference back over to Mr. Chris Oddleifson for closing remarks.

Great. Thank you. Thank you, Nick, and thank you, everybody, and we look forward to talking to you about full-year results in January. Have a safe fall. Goodbye.

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.